Friday, June 18, 2021

The latest insight into Apple’s use of capital allowances

At the start of 2015, Apple revised the structure through which the company’s sales to customers outside the Americas were organised.  This was responsible for the 26 per cent real GDP growth reported for that year.

We initially examined the revised structure here and in recent years have been tracking the consolidated outcomes for the group headed by Apple’s central international subsidiary, Apple Operations International (AOI). 

The recent publication of the AOI Group’s 2020 consolidated accounts gives us the latest insight into Apple’s use of capital allowances.  The two posts above contain details that are not repeated here.

We will start with the consolidated statements of operations and note that this covers the holding company AOI and around 80 subsidiaries operating beneath it, with the group as a whole having just over 50,000 employees.  Most, but not all of the amounts shown, arise in or pass through subsidiaries in Ireland.

AOI Income Statement 2017-2020

Some pretty big numbers there.  As the accounts note:

The Group develops, manufactures and markets smartphone, personal computers, tablets, wearables, and accessories, and sells a variety of related services.

It certainly sells a lot.  For the four years shown, cumulative net sales were close to $600 billion.  And it is massively profitable.  Pre-tax income summed to $165 billion over the four years and the provision for income taxes was a chunky $25 billion.

But we should check a few things before we get excited about that tax figure.  A company making a provision for income taxes in its financial accounts is not the same as a company making a payment for those taxes in cash.  The balance sheet is a useful place to look next.

AOI Balance Sheet 2016-2020

For our purposes we are interested in the line for Deferred tax asset.  We can see that the AOI Group had $25.6 billion of deferred tax assets at the end of its 2016 financial year.  These reduced each year and by the end of its latest financial year stood at $10.9 billion.

Thus, while there might been tax provisions averaging around $6 billion in the income statement for each of the past four years this was not resulting in an equivalent payment out of cash reserves but in the reduction in the deferred tax asset on the balance sheet.

[As we have pointed out before it is also worth noting what this balance sheet does not contain: a huge amount of intangible assets.  Ireland’s national accounts have recognised massive intangible assets yet the consolidated accounts of the group which contains the company with that asset does not. Anyway back to the tax payments.]

The difference between the provision for tax and the payments for tax is is confirmed by a supplemental item included with the consolidated statements of cash flows.

AOI Cash Flow Statement 2017-2020

There might have been tax provisions of $6 billion each year but, as the final line above shows, cash payments for income taxes averaged $2 billion a year over the past four years.  And a variation of the following paragraphs are included a number of times in the accounts:

The corporate income taxes in the consolidated statements of operations, balance sheets and statement of cash flows do not include significant US-level corporate taxes borne by Apple Inc., the ultimate parent of the group.

US-level taxes are paid by Apple Inc. on investment income of the Group at the rate of 24.5% (35.0% in 2017) net of applicable foreign tax credits. In addition, under changes in US tax legislation that took effect in December 2017, Apple Inc. is subject to tax on previously deferred foreign income (at a rate of 15.5% on cash and certain other net assets and 8.0% on the remaining income), net of applicable foreign tax credits.  The new legislation also subjects certain current foreign earnings of the Group to a new minimum tax.

The posts linked above that went through AOI’s 2018 and 2019 accounts go into detail on how the provisions for income taxes were arrived at and show the reconciliation with Ireland’s 12.5 per cent headline rate.  The earlier posts also discuss how the deferred tax asset came about – capital allowances under Section 291A of the Taxes Consolidated Act. 

For now, we will just focus on the evolution of those deferred tax assets using a table from the note to the accounts on the provision for income taxes.

AOI Deferred Tax Assets 2017-2020

We are interested in the deferred tax asset that arises due to Intra Group Transactions.  This likely includes the purchase by a now Irish-resident subsidiary of the license to sell Apple products in all markets outside the Americas.  That outlay (which may have been around $240 billion) will be eligible as a tax deduction with this provided via capital allowances.

At Ireland’s 12.5 rate of corporate tax a $240 billion deduction would be worth $30 billion which is probably where the value of the group’s deferred tax asset from intra-group transactions was in January 2015.

As we can see from the above table tax was being charged against that deferred tax asset.  The utilisation was $4.4 billion in both 2017 and 2018, $3.2 billion in 2018 and $3.3 billion in 2020.  This meant there was $7.4 billion remaining and at the current rate of utilisation will be fully exhausted in the next two to two and a half years.

The utilisation of capital allowances at that scale means that something in and around €25 billion of gross profit is being offset by a deduction for capital allowances.  As the transaction occurred before October 2017 no cap applies and, if sufficient capital allowances are available, the company can fully offset its profit with capital allowances and this is was happened in 2015, 2016 and 2017.  A small amount of profit may have been subject to tax in 2018.  Any unused capital allowances in the earlier years are carried forward as losses but essentially remain as a deferred tax asset.

As before, the key question is the amount of profit that will be subject to tax when the deferred tax asset is fully exhausted.  If nothing changes at that point then somewhere in the region of €25 billion of gross profit will be added to the taxable income of the Irish-resident Apple subsidiary that currently holds the license to sell Apple products outside the Americas. 

This would see tax payments in Ireland rise by €3 billion or so and that Apple subsidiary would almost certainly become Ireland’s largest taxpayer.  If nothing changes.

We have already seen a number of major US ICT MNCs transfer their IP back to the US (from which it should never have been allowed leave in the first place).  Apple have the option to do the same and maybe this becomes more likely as the amount of capital allowances available nears exhaustion.

If Apple were to do so, this would reverse the GDP surge that occurred in 2015 and the value added would be rightfully recorded where it is generated – in the US.  Changes that add 0.2 per cent to US GDP won’t make headlines in the same way a 10 per cent reduction in Irish GDP would.  But they essentially involve the same thing.

And further it probably won’t significantly change the company’s tax payments  - not in Ireland at any rate.  With capital allowances the profit is not currently exposed to Ireland’s 12.5 per cent Corporation Tax.  As pointed out above the profit is subject to tax in the US under the minimum tax on foreign earnings introduced by the Tax Cuts and Jobs Act (TCJA). 

This is the tax on Global Intangible Low Taxed Income – GILTI.  The Biden administration are proposed to double this from 10.5 per cent to 21 per cent.  If Apple relocates their IP to the US and continues to use a licensing structure (they could also decide to simply sell the products from the US) then the income from that license would be taxes under the Foreign Derived Intangible Income (FDII) provisions also introduced by the TCJA.  The Biden administration are proposing to abolish FDII.

There is lots of uncertainty.  But as shown here there is no doubt that the amount of remaining capital allowances Apple has in Ireland is reducing.  What was probably around $30 billion in 2015 was down to $7.4 billion in September 2020.  We won’t get many more insights into Apple’s use of capital allowances – because soon enough they will be gone. 

Monday, June 14, 2021

Why there’s no pot of gold from suggestions of German multinationals reporting low-taxed profit in Ireland

Last week’s New York Times op-ed by Prof. Paul Krugman got some attention though mainly for some of the characterisations used.  And there is a difference between a pithy remark about a set of national accounts and the pejorative use of language to describe the residents of a country.

But let’s focus on the substance of some of the points made and, in particular, this extract which draws on some comments made by Prof. Gabriel Zucman on the recent G7 agreement:

Which brings us to that G7 deal. How would the 15 per cent minimum rate work? Here’s how Gabriel Zucman – who has arguably done more than anyone else to highlight the importance of international tax avoidance – summarises it:

“Take a German multinational that books income in Ireland, taxed at an effective rate of 5 per cent. Germany will now collect an extra 10 per cent tax to arrive at a rate of 15 per cent – same for profits booked by German multinationals in Bermuda, Singapore, etc.”

It seems it is to be taken as given that the suggestion of a German multinational booking profits in Ireland is a relevant example.  But has there ever been evidence of German multinationals with profits booked in Ireland and taxed at five per cent?  Unfortunately, Germany has yet to provide aggregate data to the OECD from the country-by-country reports filed by German multinationals with the German tax authority.

There is, though, this recent CESifo working paper which uses the firm-level reports filed with the German tax authority to assess profit shifting by German multinationals. The conclusion of the paper includes the following:

However, compared to the profits in non-haven countries, profits reported in tax havens are small – only accounting for 9% of global profits.

[.]

Our findings suggest that annually, EUR 3.8 billion of EUR 125 billion of total foreign profits of German MNEs are shifted to tax havens, yielding a share of approximately 3%.

In general, estimates of the extent of profit shifting in the literature tend to be higher, although some studies, in particular Blouin and Robinson (2020), find similar magnitudes. The differences in the results may result from different methods or data sources, but they may also reveal that German MNEs are less prone to shift profits than MNEs from other countries. That in turn could reflect tighter anti-tax avoidance policies in Germany and in important host countries of German foreign investment. Another reason could be differences in profit shifting opportunities due to firm characteristics such as the importance of intangible assets.

The final points on policy and opportunities are important considerations when examining US multinationals.  While we don’t have aggregate data for German multinationals from country-by-country reports there are other salient sources that can be used.  One is Eurostat’s dataset on foreign-controlled EU enterprises.

It is not a perfect match for tax data but does point in the right direction.  Here is the gross operating surplus of foreign enterprises operating in Ireland in 2018 by controlling country.  This measure is not the same as taxable income and gross means before any adjustment for depreciation.

GOS in Ireland by Controlling Country 2018

It it clear that there is only one bar that matters.  Most of the other numbers are non-zero but are not large enough to be visible due to the axis range needed to include the figure for the US.  Germany is up towards the top of the chart and the gross operating surplus in Ireland of German-controlled enterprises is small compared to that of US-controlled enterprises.

We can see more detail of the distribution of profits of German companies across EU countries with the following table which shows the gross operating surplus of enterprises ultimately controlled from Germany by the location of those enterprises.

GOS of German controlled enterprises in EU countries

Unsurprisingly, the vast majority of the profits of German controlled-enterprises is generated in Germany.  The figures for Germany in the table include both multinational and non-multinational enterprises.  For German multinational enterprises, the rest of the table gives the amount of gross operating surplus they record in other EU countries.  The table is in rank order based on the most recently available outturn.

For Ireland, we can see that the figure has typically been around €1.2 billion in recent years which can be compared to the €117 billion of gross operating surplus that US MNEs had in Ireland in 2018.

In the above table, Ireland is below Finland, Portugal, Denmark, Slovakia and Sweden as a location for the profits of German MNEs.  And that €1.2 billion will include the profit of Germany companies which have come to Ireland to service the domestic market such as grocery retailers.

Having people take an example of a German company booking profit in Ireland stumbles on two bases. First, in overall terms, German companies do not shift large amounts of their profits to low-tax jurisdictions (likely because they can not do so under German law). And, second, aggregate data suggests that German companies do not report significant amounts of profit in Ireland (unlike US companies).

Indeed, using an approach that is incorrect but frequently used, the argument could be made that German companies are shifting profit out of Ireland.  Here are the recent accounts for BMW Automotive (Ireland) Ltd.

BMW Ireland 2019

For the years shown BMW sold about 5,000 vehicles in Ireland – across its BMW and Mini brands.  The sale of these vehicles generates the revenue for this company.  In 2019, it can be seen that after €147 million of cost of sales and €9 million of administrative expenses the company recorded an operating profit of €871,000 and incurred an income tax expenses of €120,000 (or around €24 per vehicle sold).

In 2019, BMW as a whole had revenue of €104 billion and a pre-tax profit of €7 billion.  The overall margin of the company was around 15 times higher than the margin reported by BMW Automotive (Ireland).  Why was BMW’s Irish subsidiary so unprofitable?  The result was mainly driven by the cost of sales figure.

The cost of sales is the price BMW in Ireland had to pay for the cars it sells.  It is a transfer price.  And BMW has set this price at such a level that almost no profit is left in Ireland.  Most of the profit will be reported in Germany. 

And this fine.  BMW Automotive (Ireland) does little more than wholesale cars.  It has very limited functions, assets and risks and a low profit margin is appropriate.  The designing, manufacturing, branding, pricing and lots of other things necessary before a BMW car can be sold all take place somewhere else.

Why doesn’t BMW manipulate the transfer price so that more of its profit is reported in low-tax Ireland rather than high-tax Germany? It can’t.  BMW Germany has to charge BMW Ireland the same price it charges to other wholesalers of its vehicles. 

BMW could try to have more of its profit reported in Ireland by charging BMW Ireland a much lower price.  But the German tax authority would simply ask for the price charged in other similar transactions and challenge the transfer price used.  Just as they would for all other German MNEs that might try to shift profit to Ireland. 

There might be suggestions of German MNE booking profit in Ireland to be taxed at five per cent but there aren’t many examples of it. 

Thursday, June 10, 2021

Is this Ireland’s largest taxpayer?

Ireland’s Corporation Tax revenues are concentrated along two dimensions: by company and by country.  Concentration by company can be readily seen with the figure for the top 10 payers published in a research report by the Revenue Commissioners.

Corporation Tax Receipts Top 10 2011-2020

Over the last ten years, the share of Corporation Tax arising from the top 10 payers averaged 40 per cent.  The greatest level of concentration was seen in 2020 when the top 10 share exceeded 50 per cent for the first time. 

Since 2014, overall Corporation Tax receipts have almost trebled.  The amount that comes from the top 10 has quadrupled (though it should be noted that the top 10 is not made up of the same companies each year).

If the top 10 companies all made equal payments, then their individual payments of Corporation Tax would be just under €600 million each.  These would be very large tax payments.  However, the distribution is not likely to be uniform and it is very likely that the very top payers paid much more than this average.

The second dimension along which Irish Corporation Tax revenues are concentrated is by country.  Of the numerous unusual features of Ireland Corporation Tax revenues one of the most significant is that around four-fifths of payment come from foreign-owned companies.  As the Revenue report notes:

[F]oreign-owned multinationals paid €9,657 billion (82 per cent of net CT receipts), Irish-owned multinationals €841 million (7 per cent) and non-multinationals €1.335 billion (11 per cent).

Some of those foreign-owned multinationals have a presence here to serve the domestic markets (such as retailers, banks etc.) but most of the payments in this group come from what could be considered “the FDI sector”.  There aren’t many US companies here to serve the domestic market but they have a very large presence in Ireland.  And are making very large tax payments.

Since 2016 US MNCs who are required to do so have been filing country-by-country reports (CbCR) with the IRS.  Aggregate statistics have been published here.  For the years available, the corporate income tax paid (on cash basis) in Ireland of the US MNCs who filed CbCR reports are recorded as being:

  • 2016: $4,281.3 million
  • 2017: $5,189.7 million
  • 2018: $7,944.4 million

We cannot compare these directly with the total figures in the first table above as they are in a different currency and the time periods covered do not exactly coincide.  Taking an annual average exchange rate would give a figure of €6.7 billion.  In rough terms in looks like around 60 per cent of Irish Corporation Tax receipts in recent years was paid by US-owned multinationals. 

And the IRS data shows a further remarkable outcome: the $7.9 billion paid by US MNCs in Corporation Tax to Ireland for accounting periods ending between July 2018 and June 2019 placed Ireland as the third-highest recipient of corporate tax from US MNCs across all countries.

IRS CbCR Cash Tax Paid Chart 2018

Anyway, what we can take from this prologue is that one:

  1. The largest payer of Corporation Tax in Ireland is likely to making annual payments that now exceed €1 billion.
  2. This company is likely to be part of a US MNC.

So, now we need a few candidates.  Or maybe we just need to look at one: Microsoft Ireland Research.  In recent months there have been a number of stories about a different Microsoft subsidiary, Round Island One, which is based in Bermuda. 

That these stories did not reflect the tax outcomes for the overall Microsoft Corporation or for Microsoft’s operations in Ireland is par for the course.  There haven’t been too many stories about Microsoft Ireland Research and none that have set out its tax outcomes.

In its latest annual report, Microsoft Ireland Research describes itself as:

The principal activity of the company is licensing the rights to assets owned and developed by the company to other group companies, to enable them to sell and distribute Microsoft products.  These other group companies pay a royalty to the company under these agreements.  In addition the company is engaged in product localization and product research and development activities.

Microsoft Ireland Research is an Irish-resident company.  As noted in the annual report its “accounting records are maintained at One Microsoft Place, South County Business Park, Leopardstown, Dublin 18.”  Its operations do appear to be concentrated in Ireland, including the 500 staff it had in 2020, but the annual report does say that “the company also has a branch in Turkey.” 

A 2012 report for the US Senate Subcommittee on Investigations contained this summary for Microsoft Ireland Research:

Microsoft coordinates all of its consumer product sales for Europe, the Middle East, and Africa (EMEA), out of a group of entities in Ireland. One key entity called Microsoft Ireland Research (MIR) is a cost share participant with Microsoft Corporation, sharing 30% of the costs of Microsoft’s world-wide research and development expenses in exchange for the right to sell finished products in EMEA. MIR, which is located in Ireland, is a wholly-owned disregarded CFC of Round Island One, a wholly owned Microsoft CFC which operates in Ireland but is headquartered in Bermuda. The bulk of the research and development that MIR helps finance is performed in the United States at Microsoft Corporation, with MIR responsible for conducting less than 1% of the company’s total R&D.

Filings for Microsoft Ireland Research with the CRO show that the performance of the company in recent years has been very strong. Here are the profit and loss accounts since 2017.

Microsoft Ireland Research Income Statement 2017-2020

Turnover has increased from $11.6 billion in 2017 to €33.5 billion in 2020 with operating profit rising from $5 billion to $14 billion.

Although the company describes its turnover as being derived from royalties the CSO does not seem to do the same.  Ireland’s royalty exports do not match the figures shown above.  It is likely the CSO put the revenue of this company into its “computer services” export category.  These are now running at an annual total of more than €125 billion.

Services Exports Computer Services and Royalties 2013-2021

In its International Accounts releases, the CSO notes for the Computer Services category that this:

Covers exports and imports of software that were not incorporated as part of computer hardware or physical media but separately transmitted by electronic means. The value of sales and purchases of additional software licences is also included.

The licenses sold by Microsoft Research Ireland are covered by the second sentence.  Our primary interest here is in the company’s tax payments.  We can see from the profit and loss accounts that Microsoft Ireland Research’s tax charge has gone from $628 million in 2017 to $1,803 million in 2020.  This is not out of line with the aggregate figures set out at the start of this piece.

But a company making a tax charge on its income statement is not necessarily the same as a company making a cash tax payment to a tax authority.  The payment of the tax charge could be deferred leading to a deferred tax liability on the balance sheet or the charge could be offset against an existing deferred tax asset on the balance sheet.  In both instances the tax charge would not be matched by a tax payment.  However, the balance sheet for Microsoft Ireland Research does not show substantial amounts of either deferred tax assets or liabilities.

We can get further insight if we look at the tax reconciliation statement.

Microsoft Ireland Research Tax Recon 2017-2020

And there isn’t really a whole lot that stands out here.  There is reference to the impact of capital allowances which further reduces concern about deferred tax assets.  The second item with the increase from effect of different ROI tax rates on some earnings reflects the 25 per cent Corporation Tax rate that applies to non-trading income such as interest in this case. 

The effect of foreign tax rates is very small indicating that almost all of the profit is subject to tax in Ireland.

The effective tax rate bounces around a bit but that is likely because of the inclusion of income that is not subject to tax in profit before tax.  It is possible that income from shares in group undertakings and gains on the liquidation or disposal of subsidiary would not trigger a tax liability.  As a result of that looking at the tax charge relative to operating profit may be a more reliable gauge.

Microsoft Ireland Research ETR 2017-2020

It is not the definitive word on effective tax rates but, given the aggregate figures in the profit and loss account, does seem to give a consistent indicator of what is going on.  The impact of the 25 per cent rate on non-trading income (which itself is not included in operating profit) likely accounts for the difference in recent years to the standard 12.5 per cent rate.

Using an average exchange rate would give a figure of around €1.6 billion for the 2020 tax charge which is included in the accounts in US dollar terms.  The time periods don’t coincide, and assuming the vast majority of the tax charge is paid to Ireland, then Microsoft Ireland Research could be responsible for 10-12 per cent of Ireland’s overall Corporation Tax revenues.  Such a share for the highest payer would not be out of line with the finding from the Revenue Commissioners that the top 10 companies were responsible for 50.5 per cent of payments in 2020.

Microsoft’s tax outcomes attract some attention but very little of that is directed to the tax payments made by Microsoft Ireland Research.  A Microsoft subsidiary based in Bermuda, Round Island One, makes up for it though as can be seen in the search results for each

There has been some coverage of the outturns for Microsoft Ireland Research.  This May 2019 piece focused on a dividend payment it made.  There are a few mentions in pieces on The Currency including this April 2021 piece that went though some possible implications for Microsoft’s operations in Ireland of the Biden administration proposals for taxing US MNCs. And while this piece also from April 2021 again focused on dividend payments it did set out the financial outturns for the company:

The firm recorded $33.4 billion in turnover in 2020, up from $25.7 billion. Profit at the firm stood at $15.7 billion, down from $21.2 billion in 2018.

Microsoft Research Ireland employed an average of 524 staff per month in 2020, the vast majority of whom worked in localisation and product development. The average wage at the firm was more than €130,000.

But there is one thing absent from them: a sentence setting out the tax outcomes for the company.  This April 2020 piece from The Currency got tantalizingly close when it said the following about Microsoft Ireland Research: 

Its pre-tax profit nearly doubled to $22.5 billion, largely as a result of a $17 billion gain on the absorption of a liquidated Dutch subsidiary. Its corporation tax charge, by contrast, dropped by $200 million as a result of a $1.4 billion “decrease from effect of expenses not deductible in determining taxable profit”.

The $200 million drop in the tax charge made the cut but that this was a drop from $1.4 billion in 2018 to €1.2 billion in 2019.  And a subsequent piece featuring the company did not squeeze in the $600 million rise in 2020.  The tax charges across the last three years for Microsoft Ireland Research sum to almost $4.5 billion but they remain hidden from the reader in the few pieces that actually examine the company.

For a country that has seen a trebling of corporate tax revenues since 2014, is the third-largest recipient in the world of corporate taxes from US MNCs and with payments so concentrated that last year just ten companies were the source of half of all payments there has been very little interest in setting out who is actually making those payments.  Indeed, one could say there have been efforts to avoid doing so.

Could one company have paid €1.6 billion in tax in 2020?  The degree of concentration in the payments suggests that is possible.  Could that company have been Microsoft Ireland Research? The company’s financial accounts would suggest it was.  And if it was there is unlikely to be have a company with a larger tax payment. 

And that itself is not the end of Microsoft’s tax payments in Ireland.  Another Irish-resident subsidiary, Microsoft Ireland Operations Limited, had a 2020 tax charge of $342 million and a similar analysis to the above would indicate that pretty much all of that was also paid to Ireland.

Does Microsoft even pay $2 billion of tax in total, never mind only to Ireland?  Here is the consolidated income statement of Microsoft Corporation for the past five years.

Microsoft Income Statement 2016-2020

Certainly, plenty of scope for $2 billion of tax payments there.  Indeed in 2020, Microsoft had a provision for income taxes of $8.6 billion (16.5 per cent of its $53 billion pre-tax profit) and cash paid for income taxes was $12.5 billion.  Timing differences mean provisions and payments don’t always coincide.

But maybe all this tax was paid to the US. It wasn’t.  Here’s a table taken from Microsoft’s annual 10K report for 2020 showing the split of its tax provision into domestic (i.e., US federal, state and local taxes) and foreign taxes.

Microsoft Provision for Income Taxes

The one-off distortions caused by the Tax Cuts and Jobs Act and other factors seem to have been worked out for the 2020 tax provision.  The table shows that the $8.8 billion tax provision for 2020 was almost equally divided between domestic and foreign taxes.  Indeed, for the three years shown, Microsoft had a provision for foreign taxes exceeding $4 billion in each year – so a $2 billion tax bill in Ireland cannot be ruled out. 

So, a definitive case that Microsoft Ireland Research is Ireland’s largest taxpayer has not been laid out.  But the evidence is clearly pointing in that direction.

Tuesday, April 20, 2021

The extra-ordinary tax payments of US MNCs in Ireland

The US tax collector, the Internal Revenue Service (IRS), has been publishing aggregate data from the country-by-country reports US MNCs have been filing with them.  The data is available here and the most recent year covered is 2018.

Here are a few categories from the 2018 data with the countries ranked by the amount of cash payments made for corporate income taxes to each of them.  The top 15 are shown.

IRS CbCR Ranked by Cash Tax Paid 2018

As would be expected, the United States itself is the largest recipient of corporate taxes from US MNCs.  Of the $261.5 billion of cash payments for income taxes made by US MNCs in the IRS country-by-country statistics just over $140 billion (53 per cent) was paid to the US.

Next on the list is the UK which was the recipient of $10.9 billion of corporate tax payments from the US MNCs in this data.  And extraordinarily, Ireland is next.  The IRS statistics show that US MNCs paid close on $8 billion of Corporation Tax in Ireland in 2018.  This figure is likely to be higher when the IRS updates its data with subsequent years.

Ireland is the third-highest recipient of corporate taxes from US MNCs in the world.  The scale of the payments being made here is highlighted when they are put in terms of national income.  Here they are put in terms of Gross National Income (for countries with a GNI of more than $100 billion) with the highest 30 countries shown.

IRS CbCR Cash Tax Paid as Share of GNI

The $8 billion of tax paid by US MNCs in Ireland in 2018 was equivalent to 2.6 per cent of Ireland’s Gross National Income (if GNI* is used it moves above 3.0 per cent).  No country with a GNI of more than $100 billion comes close to collecting this amount of tax from US MNCs as a share of its national income. 

The are some smaller countries where the share in Ireland is apparently eclipsed.  These are the Cayman Islands($213 million of tax from US MNCs, 6.9 per cent of GNI), Bermuda ($485m, 6.5%), The Bahamas ($516m, 4.2%) and Luxembourg ($1,398m, 3.1%).  However, these are small payments relative to very small economies and is not clear if the tax payments attributed to US MNCs subsidiaries in those countries are made to those countries.  The GNI of the Cayman Islands is around $3 billion which is 100 times smaller than Ireland and it does not have a corporate income tax from which revenue can be generated.

It is worth noting that the US itself in included in the above chart.  In 2018, the corporate tax revenue from US MNCs in Ireland as a share of GNI was nearly four times higher than it was in the United States.

Monday, April 19, 2021

We know so much about Google’s tax structure, how is it possible to get the reporting so wrong?

The taxation of US multinationals continues to make headlines. It is right that these companies are subject to intense scrutiny but given how frequently they are reported on it is surprising how frequently significant errors arise in the coverage. A recent case in point arises in this piece from The Irish TimesThe piece begins:

Google shifted more than $75.4 billion (€63 billion) in profits out of the Republic using the controversial “double-Irish” tax arrangement in 2019, the last year in which it used the loophole.

The technology giant availed of the tax arrangement to move the money out of Google Ireland Holdings Unlimited Company via interim dividends and other payments. This company was incorporated in Ireland but tax domiciled in Bermuda at the time of the transfer.

It looks like there is headline worthy stuff going on here but in just the opening two paragraphs the piece manages to utterly contradict itself.

Paragraph 1: A Google subsidiary shifted profit out of Ireland.

Paragraph 2: This Google subsidiary was based in Bermuda.

How can a holding company in Bermuda shift profit out of Ireland? Sure, Google Ireland Holdings made substantial dividend payments and distributions in 2019 but it was a payment from a company in Bermuda to its immediate parent.  Neither party to the transaction was in Ireland.  And this is clearly set out in the company’s accounts.

Google Ireland Holdings Dividend 2019

Note 9 to the accounts tells us  “the Company is domiciled and tax resident in Bermuda” while Note 10 tells us that the distributions in 2019 comprised $15 billion of financial assets, $27 billion of debt securities, dividends of $30 billion and other net assets of $3 billion.  That is the $75 billion that generated the headline.

Of course, distributions and annual profit are different things.  We can use the very same accounts the dividends and distributions figure came from to get the company’s profit.   To do that all we have to do is look at its income statement.

Google Ireland Holdings 2019 Accounts

Google Ireland Holdings certainly was a profitable company.  It had a pre-tax profit of $13.7 billion in 2019 from turnover of $26.5 billion.  Of course, as a company resident in Bermuda (which doesn’t have a corporate income tax) pre-tax profit and post-tax profit were the same.

The third paragraph of The Irish Times piece goes:

The move allowed Google Ireland Holdings to escape corporation tax both in the Republic and in the United States where its ultimate parent, Alphabet, is headquartered. The holding company reported a $13 billion pretax profit for 2019, which was effectively tax-free, the accounts show.

Hmmm. Didn’t we have a huge amount of coverage last week, including in The Irish Times itself, of proposed changes to the US minimum tax on the foreign profits of its MNCs – the so-called tax on GILTI, Global Intangible Low-Taxed Income. So, yes you can say that Google Ireland Holdings profit “was effectively tax free” once you ignore the tax that its ultimate parent, Alphabet Inc., is liable to pay on those profits to the US. 

Similarly, we could say Ireland is effectively a landlocked country – once you ignore the hundreds of miles of coastline.  We can say it but it means nothing.  

Moving on to paragraph five:

Google has used the double Irish loophole to funnel billions in global profits through Ireland and on to Bermuda, effectively put them beyond the reach of US tax authorities.

It seems somewhat odd given the above statement, that Google would have included the following note in its 2017 annual accounts:

One-time transition tax

The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion. We have recorded provisional amounts based on estimates of the effects of the Tax Act as the analysis requires significant data from our foreign subsidiaries that is not regularly collected or analyzed.

As permitted by the Tax Act, we intend to pay the one-time transition tax in eight annual interest-free installments beginning in 2018.

This one-time transition tax, or deemed repatriation tax, was levied on the profits that contributed to the dividends and distributions made by Google Ireland Holdings in 2019 and will be paid in annual installments out to 2025. 

So, absolutely you can say that for these profits Google was able to “effectively put them beyond the reach of the US tax authorities”, once you ignore the $10 billion of tax that Google will pay on them.  And, as noted above, any such profits earned since 2018 have been subject to the tax on GILTI.  That tax is in place but as it was introduced in legislation called the Tax Cuts and Jobs Act it is not clear how much revenue is being generated by it.

In overall terms, we can assess Google’s tax payments by looking at its annual financial statements.  Here are the company’s income statements for all years from 2010 to 2020, as well as a line about actual tax payments extracted from the company’s cash-flow statements. Click to enlarge.

Google Income Statements 2010-2020

All told, in the 11 years since 2010 Google has reported a cumulative pre-tax profit of $264 billion.  The provision for income taxes sums to $54 billion giving a effective accounting tax rate of just over 20 per cent.

The provision for the one-time transition tax was made in 2017 and it can be seen that the effective tax rate for that year exceeded 50 per cent as the provision for taxes included $10 billion of tax for accumulated foreign profits.

On a cash basis the company paid $41 billion of tax.  This will increase to match the provision for income taxes as future installments of the deemed repatriation tax are paid.

We move on to paragraph six

Companies exploiting the double Irish put their intellectual property into an Irish-registered company that is controlled from a tax haven such as Bermuda. Ireland considers the company to be tax-resident in Bermuda, while the US considers it to be tax-resident here. The result is that when royalty payments are sent to the company, they go untaxed – unless or until the money is eventually sent home to the US parent.

Hmmm. Untaxed that is if you ignore the minimum tax that the US has on the foreign income of its subsidiaries.  The tax on GILTI was introduced in December 2017 which is surely enough time for the reporting to catch up.

The “double irish” was original designed around the “same country exception” in Subpart F of the US tax code.  As this IRS note states passive income, such as royalties, received by the foreign subsidiaries of US MNCs was immediately liable for US tax (under the pre-2018 regime).

Generally, the US shareholder of a foreign corporation is able to defer taxation of the corporation’s income until it has been distributed to the shareholder. However, in the case of a controlled foreign corporation (“CFC”), certain types of income are subject to current inclusion (“subpart F inclusion”) by the US shareholder under IRC 951. One such type of income is Foreign Personal Holding Company Income (FPHCI), which includes income of a CFC such as dividends, interest, rents, and royalties. The FPHCI rules eliminate the deferral of US tax on income earned by certain foreign corporations from portfolio types of investments, i.e., where the company is merely passively receiving investment income rather than earning active business income. Consequently, many of the exceptions to current inclusion of FPHCI focus on the recipients of income (i.e., whether the recipients meet certain criteria). 

As the note sets out there are some exceptions to the immediate inclusion of passive income for taxation in the US.

Another exception that looks to the payor of the income for eligibility requirements is the same country exception from FPHCI under IRC 954(c)(3). Under the same country exception, FPHCI does not include dividends and interest received by a CFC from a related CFC payor which is incorporated in the same country as the recipient CFC, and which has a substantial part of its assets used in its trade or business in that same country. Similarly, under this exception, FPHCI does not include rents and royalties received by a CFC from a related CFC for the use or privilege of using property within the same country as the recipient CFC’s country of incorporation. However, the FPHCI implications/treatment of rents/royalties are outside the scope of this Unit and will be covered in a separate Unit.

This is the reason for “double” part of the moniker. The key is to have two companies registered in the same country. Their residence doesn’t matter from a US perspective.  So, Google had a Irish-registered trading company operating in Ireland and an Irish-registered holding company based in Bermuda. 

The trading company paid for the right to use Google’s technology and because the royalty paid was received by another Irish-registered company, the income was not included when earned but the tax payment could be deferred until the profit was repatriated to the US.  The 2017 TCJA abolished the deferral on taxes on this income.

The company in Ireland is Google Ireland Limited and it is the fulcrum of Google’s international operations.

Google Ireland Limited 2019 Accounts

 

Some big numbers there. Google Ireland Limited had turnover of €45.7 billion in 2019.  Of this, around €14.3 billion went on the cost of sales which in this case is fees paid to website owners for hosting ads from Google’s services.

From gross profit if €31.4 billion the company incurred €29.7 billion of administrative expenses.  These include staff and premises costs in Ireland but by large the largest component is the royalty it must pay for the license to see advertising using Google’s technology.

After investment and other income, Google Ireland Limited had a pre-tax profit of just under €2 billion and a tax provision of around €250 million (c.12.5 per cent).  This, along with its €600 million of wage costs and purchases from Irish suppliers represents its contribution to the Irish economy.

The main supplier for Google in Ireland is the entity that produces the technology it uses.  Due to a Irish withholding tax in place at the time the structure was set up the royalties payments make a detour to The Netherlands (the “dutch sandwich”) before finding their way to Bermuda.  Under the EU’s Patents and Royalties Directive, Member States can levy a withholding tax on royalties paid to another EU Member State. 

At the time, Ireland would have levied this withholding tax if the payments went from Ireland to Bermuda but this was easily circumvented  by directing the payments first to The Netherlands and then on to Bermuda.

We have already looked the accounts of the Bermudan company above. It received very significant revenues but we can also saw that it incurred very significant costs.  The accounts give a breakdown of some of these.

Google Ireland Holdings Turnover and Costs 2019

The largest cost is R&D expenditure.  This is a holding company with no employees so it obviously isn’t doing the R&D itself. This is the payment for someone else to undertake the R&D on its behalf.  As the accounts note:

Administrative expenses

Administrative expenses increased from US$11.1 billion in 2018 to US$14.1 billion in 2019, an increase of US$3.0 billion. This increase is primarily due to an increase in research and development (“R&D”) expenses. The Company incurred US$10.4 billion (2018: US$9.6 billion) of R&D expenditure in the year pursuant to a cost sharing agreement with a fellow group undertaking. These expenses increased due to an increase in the worldwide spend on R&D.

Google Ireland Holdings was part of a cost-sharing agreement with Google in the US.  The R&D takes place in the US but the cost was split between the US parent and Google Ireland Holdings.  Google Ireland Holdings made a contribution to Google worldwide spend on R&D based on the relative size of the market it serves.  It look like Google Ireland Holdings paid for around 40 per cent of Google overall spend on R&D.

So while Google Ireland Limited did make a royalty payment of around €26.5 billion that ended up in Bermuda in 2019 around half of that was further transferred to the US to cover the costs of Google technicians, engineers and developers who are behind Google’s technology.  The residual that was left in Bermuda was subject to the US GILTI tax.

However, Google does nothing in Bermuda to justify the profits earned by Google Ireland Holdings.  In recent years, the OECD, through their ongoing BEPS project, have been proposed updates to transfer pricing guidelines that would ensure that the location where a company’s profit is reported better matches the location of the substance that generates that profit.  Google’s structure with $13 billion of profit in Bermuda in 2019 did not align with that.

The changes implemented through the OECD in relation to profits linked to intangible assets such as those produced by R&D are summarised as DEMPE – does a company do sufficient development, enhancement, maintenance, protection or exploitation of the intangible asset do justify the profit allocated to it?

Google Ireland Holdings does nothing so there is no way it had sufficient DEMPE functions to justify the profits allocated to it.  This means that payments made to Google Ireland Holdings would not be tax deductible.  It is these changes to transfer pricing guidelines that have brought an end to structures like these.  For Google this happened at the end of 2019.

Here a paragraph from The Irish Times article that is actually correct. It is a copy and paste of a statement from Google.

“In December 2019, in line with the OECD’s base erosion and profit shifting (BEPS) conclusions and changes to US and Irish tax laws, we simplified our corporate structure and started licensing our IP from the US, not Bermuda. The accounts filed today cover the 2019 financial year, before we made those changes.”

So, the Irish company still has to pay for the rights to use Google’s technology but now those payments go direct to the US instead of ending up in Bermuda.  This is as it should be.  The US should not have allowed a cost-sharing agreement that allowed the profits from activities undertaken within the US to leak out. 

When they did leak out the US wanted their MNCs to “exhaust all remedies” to minimise the amount of foreign tax they paid.  Locating the profits in Bermuda was US companies complying with the recommendations of the IRS. 

This is from an IRS note that sets out what US MNCs are expected to do if they wished to avoid double taxation:

The United States taxes income on a worldwide basis. To prevent double taxation, under the Internal Revenue Code (IRC) U.S. taxpayers are allowed a credit for foreign income taxes paid. However, the ability to credit foreign income taxes paid is limited. Pursuant to Treasury Reg. § 1.901-2(e)(1) U.S. companies may not obtain credits for foreign taxes paid in which they are not legally compelled to pay. If the U.S. Treasury were to allow foreign tax credits (FTCs) without requiring U.S. taxpayers to effectively and practically reduce their foreign tax payments as legally imposed, taxpayers would have no incentive to challenge any foreign tax, whether or not properly imposed. As a result, foreign tax costs may potentially be improperly shifted to the United States. 

As a general rule under Treas. Reg. Section 1.901-2(e)(5)(i), taxpayers cannot claim foreign tax credits for amounts paid to foreign taxing authorities where they have failed to exhaust all effective and practical remedies (including competent authority procedures where applicable).

So what can appear as egregious tax avoidance from, say, a European perspective can be seen as simply ensuring tax payments are maximised from a US perspective.  The US wanted their MNCs to locate their foreign profits in no-tax jurisdictions such as Bermuda.  This ensured that US payments were maximised, albeit that the US had a terrible record of actually collecting this tax.

The updated transfer pricing rules means that restrictions have rightfully been placed on companies reporting their profits in jurisdictions where they have no substance.  Google has responded this need to better align its profit with its substance by licensing its IP from the US and not Bermuda and this has changed how its profit is taxed.

What has been the effect of this in Ireland?  In reality, there is very change.  The Irish company is still paying for the technology it uses but the destination of those payments has changed.  We can see this from balance of payments data.

Royalty Imports to United States 2008-2020

Whoa!  For pretty all of the last decade royalty payments from Ireland to the US were around €2 billion a quarter.  They skyrocketed in 2020 and, all told, around €52 billion of royalty payments went from Ireland to the US.  It is more than just Google that have moved to licensing their technology for international markets from the US.  Facebook have too.

This means that in 2020 the trading companies in Ireland continued to collect tens of billions in revenue from selling advertising on Google’s and Facebook’s platforms.  For the rights to sell the advertising, their Irish subsidiaries paid for the technology they are using and these payments are now being directed to the where the DEMPE activities that produce the technologies are located: the United States.  These payments may add 0.1 or even 0.2 per cent to 2020 US GDP.

But I wonder how the Irish reports will butcher their “analysis” of Google’s 2020 accounts in Ireland when they are published this time next year?  Because all the evidence is that butcher it they will. It seems “most read” or “most likes” is more important than “most accurate”.

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